Enhanced Pension For Health Plan Waiver Equals
Coverage Reduction

>The reduction of retiree coverage falls within the
meaning of Section 420(c)(3)(E) of the Internal Revenue
Code, the Internal Revenue Service (IRS) said in Revenue
Ruling 2004-65.
The IRS based its decision on reading the applicable
statues as they apply to an employer action to reduced
retiree health coverage.

>To better illustrate the case for plan sponsors, the
IRS provides a scenario in which an employer maintains a
defined benefit plan that contains a retiree health
benefits account.
As the plan is established, the company can opt to
make qualified transfers of excess pension assets
from time to time to fund applicable health benefits and
for purposes of this illustration, a transfer of pension
assets is done at the end of the plan year in 2002.
At the beginning of 2004’s plan year, the employer
makes an offer to retirees covered under the plan to
receive enhanced pension benefits in return for waiving
their applicable health benefits.

The major issue with the offer is found Section
1.420-1 of the Income Tax Regulations.
This section offers plan sponsors guidance on
determining what constitute “significantly reduced retiree
health coverage during the cost maintenance period.”
Per the regulations, there is a significant reduction
if:

the employer-initiated reduction percentage for
any taxable year beginning on or after January 1, 2002
exceeds 10%, or the sum of the employer-initiated
reduction percentage for that taxable year and all
prior taxable years during the cost maintenance period
exceeds 20%.

the employer-initiated reduction percentage for
any taxable year equals the number of individuals
(retired employees plus their spouses and dependents)
receiving coverage for applicable health benefits as of
the day before the first day of the taxable year whose
coverage for applicable health benefits ended during
the taxable year by reason of employer action, divided
by the total number of such individuals receiving
coverage for applicable health benefits as of the day
before the first day of the taxable year.

Additionally, Section 1.420-1(b)(4) offers guidance
for determining an employer-initiated reduction percentage
in the context of an “employer action.”
Per this section, eligibility for retiree health
benefits ends by reason of employer action if the
individual’s eligibility for applicable health benefits
ends as a result of a plan amendment or any other action of
the employer that has the effect of ending the individual’s
eligibility.

Applying these, and other standards to the present
case,the IRS finds “if a covered individual accepts the
offer to waive such coverage, the cessation of coverage
will be treated as an employer-initiated reduction in
coverage for purposes of determining whether the employer
has significantly reduced retiree health coverage during
the cost maintenance period.”